Look Out Below: Deposit Insurance Is an Unknown Cliffhanger

I’m going to let you in on a little secret, probably missed among the dire headlines about the fiscal cliff. Don’t be too alarmed, just give it a little bit of thought:

The money deposited in your checking or savings account in your local bank might not be as safe as you think.

Let me explain why, and then we can decide whether to stress out.

Up until 2008 the Federal Deposit Insurance Company (FDIC) insured commercial and consumer bank deposits up to a maximum of $250,000. As the financial crises worsened in late 2008, the FDIC introduced the Transaction Account Guarantee (TAG) program, which provided for protection of an unlimited amount of money in non-interest-bearing accounts.

Is essence, the TAG measure placed an insurance policy on what has grown into more than $1 trillion — yes, you read that correctly — of deposits sitting in TAG accounts. That number is around 13% of all bank assets, and most of it comes from corporate accounts.

Here’s the problem: The insurance policy runs out on Dec. 31, and those deposits will go back to being insured up to a maximum of $250,000. Look out below — nearly $1.4 trillion in deposits is over the $250,000 threshold for insurance, according to a report[1] offered up by Goldman Sachs.

The potential outflow of monies from bank coffers could be, if not catastrophic, certainly market-moving. Estimates vary on how much might come gushing out, with $100 billion to $300 billion looking to be about the consensus. Where will the monies flee if the program isn’t either extended or altered, and what could the fallout be?

Stephan Foley writing[2] in the Financial Times quotes Jim Lee, head of U.S. interest rate derivative strategy at RBS:

Corporate treasurers are likely to put the money into Treasury bills or, more likely, into money market funds that invest in government securities. That could lead to a squeeze in short-dated debt commonly used as collateral between financial institutions.

The net result of the inflow of monies into these securities is they pressure short term rates even further, lowering yields even more than today. Indeed, short-term U.S. rates on these securities could turn negative.

Not good for investors, who could see ever lower rates on their checking and savings accounts at JPMorgan (NYSE:JPM[3]), Citigroup (NYSE:C[4]), and Wells Fargo (NYSE:WFC[5]), just to name a few of the money center banks that have what the Goldman study suggests is a disproportionate share of those deposits. In addition, short-term government holdings accounts like Vanguard Short-Term Government Bond ETF (NASDAQ:VGSH[6]) could be affected fairly dramatically.

As for the purely political aspect of the program, let’s face it: The fiscal cliff and the debt ceiling get more of the attention, and it probably isn’t on the agenda topic list when President Obama and Speaker John Boehner get together for lunch. But the American Bankers Association (ABA) and the Independent Community Bankers of America (ICBA) are lobbying for two- and five-year extensions of the TAG program, respectively. Only time will tell if this deposit insurance patch gets swept up with other legislative momentum, or swept under the rug instead.

So is this “hidden cliff” cause for concern? Sure. Do I believe that the Citigroups, Morgan Stanleys (NYSE:MS[7]) and Bank of Americas (NYSE:BAC[8]) of the financial world have the brainpower and strategic acumen to somehow make it all work out for their benefit? Absolutely.

In the meantime, hold onto your hat and watch your bank statements … it’s a long drop if nothing gets done by the end of the year.

Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing, he did not hold a position in any of the aforementioned securities.

Endnotes:

according to a report: http://www.goldmansachs.com/gsam/pdfs/GLM/research-FDIC-deposit-guarantees.pdf